Hitting the Tax-Break Jackpot; U.S. Companies Benefit From One-Time Law on Foreign Profits

By EDMUND L. ANDREWS

Published: February 1, 2005

When Congress passed a one-time tax break on foreign profits last fall, lawmakers said their main purpose was to encourage American companies to build new operations and hire more workers at home.

But as corporations are gearing up to bring tens of billions of dollars back to the United States this year, adding jobs is far from their highest priority. Indeed, some companies say they might end up cutting their work forces.

Hewlett-Packard, for example, which has accumulated $14 billion in foreign profits and lobbied intensively for the tax break, announced on Jan. 10 that it would continue to reduce its work force this year. That would come on top of more than 25,000 jobs that it eliminated during the previous three years.

Hewlett, like several other companies expecting to benefit from the tax break, said it had not made any final decisions about what to do with the money.

Kellogg, the cereal manufacturer, announced on Monday that it would use the new tax break to bring back about $1 billion in foreign profits. Among other things, Kellogg said it would use the money to ''look at close-in acquisitions'' of other companies.

And Procter & Gamble announced that it had about $10.7 billion in foreign profits that could be brought back at a fraction of the normal corporate tax rates. Though P.&G. said it had made no decisions, it would be eligible under the law to use that money to help finance its planned $57 billion takeover of Gillette.

When the law was being debated, Senator John Ensign, a Republican of Nevada and a leading sponsor of the tax provision, predicted that it would prompt a surge of new investment in the United States and lead to hundreds of thousands of new jobs.

''There is not a lot of incentive for U.S. companies to bring the money back from overseas now because of the high tax penalty,'' Mr. Ensign said last year. ''This legislation is exactly the extra boost our economy needs.''

Even if it does not lead to many new jobs, supporters of the legislation say, anything that allows American companies to allocate their funds more rationally should produce economic benefits.

By far the biggest tax windfalls will go to pharmaceutical companies. Pfizer, whose products include Viagra and the cholesterol-lowering drug Lipitor, said it might bring back as much as $38 billion in foreign profits.

Four other pharmaceutical companies -- Eli Lilly, Bristol-Myers Squibb, Johnson & Johnson and Schering Plough -- announced plans in the last week to bring back as much as $37 billion among them.

But many industry analysts are skeptical that drug companies will use the money for either further expansion beyond what they were already planning or for additional hiring.

''The pharma companies are cash-rich to begin with, and they don't need any additional cash to expand their operations,'' said Hemant K. Shah, an industry analyst in Warren, N.J.

Far more likely, Wall Street analysts said, is that the companies will use their tax windfall to license drugs from others, take over other companies or simply shore up their balance sheets.

The tax break was part of the American Jobs Creation Act, a huge corporate tax bill that Congress passed last fall in response to pressure from the European Union to resolve a long-running trade dispute. As part of that measure, a ''homeland reinvestment'' provision allowed companies to bring foreign profits into the United States at a much lower tax rate.

To qualify for the one-time tax break, which essentially allows companies to pay 5.25 percent rather than 35 percent on the foreign profits, a company has to submit a ''domestic reinvestment plan'' that shows how it would invest the money in the United States.

Wall Street analysts estimate that American companies have piled up at least $400 billion in profits outside the United States, deferring American corporate taxes on those profits as long as they were kept abroad.

But the law and guidelines issued by the Treasury Department give companies a wide berth in defining their investment plans.

The Treasury Department said companies could use the money to acquire other companies, pay down debt, buy up patents, cover the costs of litigation or simply finance the costs of sales and marketing.

In a disappointment to some investors, however, officials ruled that companies cannot use their repatriated foreign profits to pay dividends or support stock repurchase plans.

But analysts said many companies might well use the money to indirectly finance share buybacks.

''If you use repatriated capital for something that you might have used other capital for,'' asked Richard Evan, a pharmaceutical analyst at Bernstein Research, ''can you then use that other capital to buy back shares or pay dividends?''

Robert S. McIntyre, director of Citizens for Tax Justice, a labor-backed research group that scrutinizes corporate tax practices, argued that nothing in the law required companies to do what Congress intended.

''Money is fungible,'' he said. ''You take it from one pot, and you put it in another.''

Eli Lilly, whose products include Prozac, the antidepressant, said earlier this month that it might bring back as much as $8 billion in profits that have accumulated overseas.

Terra Fox, a spokeswoman for Lilly, said the company expected to spend about $2 billion this year on worldwide capital expenditures, up from $1.9 billion last year, and that the United States would take up a higher share of the worldwide total this year.

But Lilly also indicated that it might use the money to finance much of its standard operating expenses. ''Repatriating the cash allows us to make continued significant improvements in physical assets and people without incurring additional debt,'' Ms. Fox said. ''These actions will ultimately contribute to job creation and retention.''

Many industry analysts are hoping that the big pharmaceutical companies actually avoid big new investments.

''Their costs structures right now, quite frankly, are fairly bloated,'' said Tony Butler, a phamaceutial analyst at Lehman Brothers. ''Adding head count right now doesn't make sense to me.''

Hewlett, the computer and printer manufacturer, was one of the most vocal champions of the tax break on foreign profits and has accumulated about $14.5 billion that could be eligible for repatriation. Company executives suggested last year that they wanted to use some of their foreign profits to pay down debt, which ballooned after Hewlett bought Compaq several years ago.

The Oracle Corporation, the leading maker of database software for running major businesses, has about $3 billion in foreign profits that could be brought back to the United States at a low tax rate. Analysts expect Oracle to use that money to help pay off its recent takeover of PeopleSoft, which also makes business application software, for $10.3 billion.

In the meantime, Oracle plans to consolidate the two companies, reducing its combined work force by 5,000 people, to 50,000.

Larry Ellison, Oracle's chairman, told analysts last week that the takeover of PeopleSoft would make his company a much stronger competitor against its biggest rival, SAP of Germany. ''I think we're going to have a much firmer foundation to build out applications than they will,'' Mr. Ellison said, ''because we will have a much larger base.''

Drawing (Illustration by Nick Bilton/The New York Times)

Chart: ''Waiting Offshore''
A one-time tax break will allow companies to pay a fraction of the normal tax rate on billions of dollars of profits gained overseas.